PCAOB finds common threads in ICFR audit deficiencies

Insufficient testing of controls and failure to properly evaluate
control deficiencies were among the common findings that led the PCAOB
to issue a summary of observations from 2010 inspections of audits of
internal control over financial reporting.

The PCAOB on Monday released a 31-page
report on deficiencies in firms’ audits of internal control over
financial reporting. The report does not identify individual audits,
but includes information summarized from inspections.

Deficiencies found under PCAOB Auditing Standard No. 5, An Audit
of Internal Control Over Financial Reporting That Is Integrated With
An Audit of Financial Statements, were included in the report,
which was issued to help inform auditors on common problems to avoid.

In 46 of the 309 audit engagements inspected by the PCAOB in 2010
that were referenced in the report, the PCAOB found that the firm had
failed to obtain enough evidence to support its audit opinion on the
effectiveness of internal control.

In an additional 50 of the 309 audit inspections, the PCAOB found
what it considered to be deficiencies in firms’ quality-control
systems that required remediation. Those deficiencies did not mean the
audited companies had materially misstated financial statements or had
inadequate internal controls. Rather, the deficiencies generally
indicated failure by engagement teams to comply with their firms’
methodologies, according to the report.

The most commonly identified deficiencies named in the report were
firms’ failures to:

Identify and test controls that are intended to address the
risks of material misstatement.

Sufficiently test the design and operating effectiveness of
management review controls that are used to monitor the results of
operations, such as:

Monthly comparisons of budget and
actual results to forecasts for revenues and expenses.

Comparisons of other metrics, such as profit margins and
certain expenses as a percentage of sales.

Quarterly balance sheet reviews.

Obtain sufficient evidence to update the results of testing of
controls from an interim date to the company’s year end (the
roll-forward period).

Sufficiently test the system-generated data and reports that
support important controls.

Sufficiently perform procedures regarding the use of the work of
others.

Sufficiently evaluate identified control deficiencies and consider
their effect on both the financial statement audit and the audit of
internal control.

“These findings have increased to a point over the last couple
of years where we wanted to put out this … report,” PCAOB Director of
Registration and Inspections Helen Munter said last week at
the AICPA Conference on Current SEC and PCAOB Developments in Washington.

Potential root causes of the deficiencies described in the report included:

Improper application of the top-down approach to the audit of
internal control as required by AS No. 5.

Decreases in audit firm staffing through attrition or other
reductions, and related workload pressures.

Insufficient firm training and guidance, including examples of how
to apply PCAOB standards and the firm’s methodology.

Ineffective communication with the firm’s information system
specialists on the engagement team.

Cindy Fornelli, executive director of the Center for Audit
Quality (CAQ), said the auditing profession recognizes the need for
improving performance in this area and has devoted significant
resources to the effort over the past year. The CAQ is affiliated with
the AICPA.

“We encourage all auditors to consider the items noted in planning
and performing public company audits,” Fornelli said. “We also
encourage preparers and audit committee members to familiarize
themselves with the report as it may contain observations that might
be useful in improving upon the design or operating effectiveness of
internal control over financial reporting.”

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